Tuesday, September 7, 2010

Crawling Out From Under An IIROC

IIROC REPORT: New Product Due Diligence Regulatory Review– Common Deficiencies and Requirements for Written Policies, Procedures and Controls

The good folks at IIROC have just released a fresh report designed to hold the investment dealer industry’s feet to the fire! They had their rapid response SWAT team swarming over the latest dealer fiasco's to give investors the heads up on current and relevant deficiencies in the sales of both Principal Protected Notes (PPN) and.... well, basically every new product that comes along!

The fact that these issues were extremely relevant in 2007 and are far less useful or timely now would seem to mean little to our conscientious industry sheepdogs, oops watchdogs, at IIROC. The inspectors at IIROC seem to believe the best time to inspect the barn is after the livestock has gone missing. The good news is that in only 2 short years from 2008-2010, the inspectors were able to confirm the barn door was and still is, wide open!

In effect, IIROC is really disclosing how useless their services are to investors. The reason you inspect is to head off problems not define what went wrong. The regulatory environment in Canada acts as a great coroner..... however what investors need is a good diagnostician! This problem is not new and does not appear to be getting any better!

Barn Door Warnings:

1- Mutual Fund Disclosure Practices are a mess in Canada. This is despite of regulatory reviews that have proposed, reviewed and analyzed the issue since as far back as 2002. According to an article in Advisor.ca in 2009, “POS disclosure has been a major issue of contention in the industry for more than a decade. It was a major plank of the work done by former Ontario Securities Commissioner Glorianne Stromberg in the late 1990s.” So, if you cannot work out a simple two page disclosure in a decade, what actual value do you add?

2- LEVERAGED ETF’s were a significant addition to the product line-up for advisors heading into the current mess. These are high risk leveraged products which can drain an account faster than you can imagine. So what training and skills did advisors require before pushing them on investors in the stock crash of 2008.... apparently only the skill to calculate a large up front commission fee. And who was there to protect investors? Well, not IIROC since the issue was driven primarily by FAIR Canada, an investor advocacy group that issued a warning report on leveraged ETF’s in May of 2009 after IIROC had watched over $2 billion in these funds get traded over a period of over two years! Hello.....watch dogs are supposed to sound the alarm before I get robbed not after!

3- Money Market Funds were actually being sold at a time when the return was less than the fee to own them. One would think this would jump off the page as an opportunity for a regulator to regulate the actions of dealers managing and selling the products. But, again the outcry was from others but not from our watchdogs!

Without getting too sidetracked, I think you get the issue! Investors in Canada are not being proactively protected when a self regulatory body such as the IIROC only appears willing to pull its thinking appendage out of its output channel well after the damage is done. It appears equally obvious that reviews such as this one are only being organized after others have blown the whistle on abusive practices. It cannot be coincidence that these reports are general and never seem to provide concrete examples of who benefited from the problem at hand and what were the consequences to those who benefited.

Report Highlights: I think the report truly does speak for the industry practices, or lack their of, so let’s look at the conclusions from the report itself:


1- Absence of a clear definition of “new product” : This conclusion is simply that dealers do not even know what a new product is. They can sell it no problem and they understand the commissions with no problems.... but knowing if a product was available before last week is a little tougher!

2- Absence of an adequate analytical framework for the consideration of whether the “new product” should be offered :I guess we should not be surprised if the dealers do not check on suitability of the new product given the point above that they do not even recognize a new product when they start selling it. I guess the dealers are not as professional and diligent as new car sales people who can tell you the features on a new car model within 30 seconds of the car arriving on the lot! I would bet however, every advisor knew within 30 seconds what commissions and trailer fees were available.

3- Absence of consideration of proficiency, training and marketing issues: Again, it is a wonder that new complex financial products can get on the shelf at major brokerage firms with no consideration whatsoever to the ability of the advisor to understand and properly explain the product. A great example was the variable annuities which were so popular that Manulife is choking on the sale of the product. An advisor told me straight up that they called in the product rep from Manulife and after the presentation the advisor had no clue how the product worked but was fine to begin selling it!

4- Absence of Product Due Diligence Committees: This last point helps explain the term “reasonable deniability”. The dealers do not create committees to review new products because then they would be aware of the risks and training needed before the product could be sold. It would also increase the risk of a lawsuit since written minutes acknowledging the concerns raised above would create liability for the firm. No, the decisions are made with open eyes and with malicious intent; never create a committee that exposes risk which must then be disclosed and dealt with.

“So, what now our hardy and tardy regulators? Another few years of study, another memo on best practices?”

“You have published findings that by your own report are atrocious! Investors have lost and are continuing to lose millions due to these deceptive and incompetent practices.”

“ What is the call to arms? How do we use this information to better improve our industry? How do we ensure investor rights and interests come first?”

“ What..... do I have a quarter......and I should call somebody who what?”

Oh, I get it. Thanks for your report on what we should have done in 2006 but still are not doing in 2010; and will not be required to do now that you have filed your report! "We couldn't have not done it without you!"

sois mike

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